From Volume 6, Issue 24 of EIR Online, Published June 12, 2007

World Economic News

Continued Japanese Carry Trade Could Hit China

June 9 (EIRNS)—If the yen keeps falling against the dollar, counter to every other world currency, and were China to end its foreign exchange controls, China itself could be hit with a yen-renminbi (RMB) carry trade that would send its already huge foreign reserves skyrocketing to $3 trillion, Chinese financial analyst Wan Xiaoxi warned in an interview with China Business News (June 9).

Wan, an analyst with China Southern Fund, said that the continued fall of the yen is encouraging the yen carry trade and exacerbating international imbalances. He called the fall of the yen a "malevolent depreciation," and obviously counter to the steady rise of the RMB and every other leading currency, against the dollar. "All the world's major currencies are appreciating against the dollar—except for one. The fact is that the currency of the world's second-largest economic power has been devalued since 2005 in a malevolent way, and this is the major cause of the global imbalance," Wan said. Were there to develop an "RMB carry trade," China's forex reserves, already some $1.2 trillion, the largest in the world, might blow out to $3 trillion in two to three years, warned Wan.

China's government has been emphatic that "reform" of China's international currency policy will be carried out at some future time, and under controlled conditions. Wan pointed out that Japan's trade surplus, about the same as China's in 2005 at $160 billion, in the first half of 2006, fell below China's. This is due to the fall of the yen, while the Chinese RMB is slowly rising: it has appreciated 5.8% against the dollar, and 14.6% against the yen since the trading band was widened in July 2005. The yen interest rate is 2-3% lower than the RMB, giving fairly high returns for carry trades between the two currencies.

Fitch: Hedge Funds in Debt Markets Pose 'Unheard-of Risks'

June 6 (EIRNS)—As the influence of hedge funds on key segments of the credit markets continues to grow at a dramatic pace, transforming the "swap" markets which supposedly insure debt against default by the use of derivatives contracts, Fitch Rating service warns of lurking, large liquidity risks.

Debt or credit-based hedge-fund assets are reported to have reached over $300 billion in 2005, a six-fold increase from five years before, according to the IMF. Based on research published by Fitch today, this number excludes the multiplier effect of leverage. Therefore, that $300 billion of assets equates to $1.5 trillion-$1.8 trillion deployed into the credit markets by the hedge funds, at typical leverage levels of $5-6 borrowed for every dollar of the hedge funds' assets risked, says Roger Merritt, managing director in Fitch's Credit Policy Group. This effective leverage is what amplifies the impact of hedge funds on credit markets.

The rating agency says that the growing role of hedge funds in the credit markets represents a true paradigm shift. Hedge funds now account for nearly 60% of the trading volumes in the $30 trillion collateralized-debt securities market, and provide significant capital flows to all areas of the cash credit markets. In a market downturn, the potential for a forced unwind of hedge funds' credit assets cannot be discounted, and could lead to correlations that are different than historical expectations. Even a temporary dislocation in the credit markets could lead to a rash of defaults, Fitch warned.

Private Equity Funder Warns of Major Defaults

June 6 (EIRNS)—One of the biggest lenders to private equity funds, warned investors yesterday that "a glut of cheap debt means buy-out firms are not pricing in risks on their bids or leaving any room for deals to turn sour," the London Times reported today.

Intermediate Capital Group said the structure of deals was now so risky that, "it was almost inevitable there would be defaults, especially on the larger multibillion deals where the appetite for risk was even greater," the Times reported; it quotes Philip Isherwood, European strategist for Dresdner Kleinwort in London, saying: "The risk is that default rates rise, then the cost of debt starts to rise and some of these deals will inevitably start to fall over."

Central Bankers: Hedge Funds Threaten World Markets

June 5 (EIRNS)—The growth of the hedge-fund industry is "too influential to ignore," Bank of Japan governor Toshihiko Fukui told a monetary conference of international bankers in Cape Town, South Africa. "In times of stress," these funds add volatility to the markets, Bloomberg reported. Fukui's warning was but one of many issued on the risks which private equity and hedge funds pose to the international financial system at the conference today.

European Central Bank President Jean-Claude Trichet worried that "a triangle of vulnerability" exists that could trigger an upset to the financial markets. Trichet identified the three triggers as 1) low-risk premiums on debt instruments, 2) the explosion of unregulated hedge funds, and 3) private equity firms combined with their widespread use of complex new credit derivative instruments, according to South Africa's Engineering News.

"A shock at any corner of this triangle could have implications for the other two," Trichet told the conference. "For instance, a significant turn in the credit cycle could mean that credit-protection sellers, such as hedge funds, could become unable to make due payments to banks." The European banker added, "Similarly, if widespread problems were to emerge at hedge funds or private equity firms, which are active in the CRT [credit risk transfer] markets, this could even spark a downturn in the credit cycle."

Even though Trichet said circumstance are "unpredictable," he merely asked that investors self-regulate and voluntarily monitor their transactions with hedge funds.

Hedge Fund, LME Accused in Assault on World Copper Market

June 5 (EIRNS)—A hedge fund that has lost big in the metals markets this year, is manipulating the global copper market and wildly driving its prices up, according to an industry source.

Red Kite Management LLP, based in London, and started in 2005 by metals traders from HSBC Bank Corp., is a large hedge fund with over $1 billion in assets under management. After making profits of over 100% in the hedge-fund-driven hyperinflation in metals and commodities of 2006, Red Kite lost something between 30% and 50% in the first few months of 2007, according to reports in financial wires.

But sources say that Red Kite has gotten Chile's huge copper-mining combine Codelco to manipulate both reported and actual shipments of copper to China, to throw the Shanghai copper futures markets into extreme volatility and confusion. This has driven copper futures prices back up nearly to $7,500 a metric ton on the London Metals Exchange (LME).

The International Wrought Copper Association, made of up large corporate and government users of copper, accuses the LME itself of aiding the hedge funds' speculation and manipulation of the price. Inventories of copper were reported as falling in the first week of June on the LME, but also at the Shanghai Futures Exchange, despite huge reported imports of Chilean copper to Shanghai (up more than 100% in recent months, from a year earlier). "The surprise this month has been the continual drops in LME inventories and the fact that Shanghai stocks have not risen, given the level of Chinese imports in the first four months," said Nick Moore, a London-based metals analyst at ABN Amro Holding NV, to Bloomberg on June 5. These imports have been at such suddenly elevated prices, that Shanghai copper traders claim they are reselling the copper at losses of $600-700 a metric ton to domestic users.

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